Fractional shares have been touted as a game-changer in the stock markets, and rightly so. They’ve helped make the stock market more inclusive of cash-strapped investors, among other benefits. But while these shares have their advantages, they pack a few downsides that anyone looking to try this type of investment method should know.
Some of the reasons you should not buy or trade fractional shares include:
- With fractional shares, you lose a small portion of your return to your broker.
- There may be additional costs associated with fractional shares.
- With fractional shares, liquidity may be an issue.
- Stock availability may be limited with fractional shares.
- Fractional shares may come with trading limitations.
- Fractional shares may not give you voting rights.
Stick around for an insightful discussion as we shed more light on the above drawbacks of buying or trading fractional shares.
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6 Reasons Buying & Trading Fractional Shares May Not Be Worth It
Described below are the top six reasons that make buying and trading of fractional shares not worth it:
With Fractional Shares, You Lose a Small Portion of Your Return to Your Broker
By this statement, I’m not referring to brokerage fees (although that’s a disadvantage of fractional shares that we will cover later on). Instead, I’m talking about you losing small portions of your dividends to your broker with fractional shares.
Let me explain.
Historically, the consensus has been that brokers can keep fractions of dividends that are less than one cent ($0.01). The problem is, these fractions are more likely to emerge when trading fractional shares because splitting a share also divides up the attributed dividends.
How does that translate to you losing a small portion of your returns to your broker? Let’s use an example to illustrate:
Suppose you own a whole share of company X that pays $0.07. If that dividend gets paid, you get that amount in total.
Now, you’d expect someone who owns half of the same share to get $0.035, but that’s not quite the case. Instead, this investor would get $0.03. The broker would pocket the extra $0.005 because it’s difficult for them to attribute fractions of a penny to each individual, more so when serving many clients.
From the above example, it might not seem like a big deal that your broker pockets $0.005 of your return. But when this happens to many customers over a long period, it can snowball into something significant for the broker.
What’s more, owning a tiny fraction of a share can result in your broker keeping your entire dividend. This is more likely to happen if the underlying share is priced low and pays small dividends.
Again, let’s use an example to clarify things:
Picture this: You own a fraction of a low-priced share. After multiplying the per-share-dividend amount with the portion you own, you realize that you’re entitled to a dividend of $0.009.
In this case, your broker would keep the entire dividend because, as we mentioned earlier, they’re allowed to keep anything less than a cent. That $0.009 could be a significant percentage of your stock’s value, and you may end up missing it four times each year if dividends are paid quarterly.
Indeed, trading fractional shares means you’ll inevitably lose some of your return to your broker. Sometimes, you may end up missing out on dividends altogether, and the worst part is that there’s no way to channel these lost returns towards covering other fees your broker may be charging.
There May Be Additional Costs Associated With Fractional Shares
Splitting whole shares into fractions involves a bit of background financial engineering. This process isn’t free, meaning your broker incurs some additional costs to create fractional shares.
As you might expect, they must recoup these additional costs one way or another to stay profitable. Most of the time, this is done through additional brokerage fees, meaning you’ll likely pay more in brokerage fees for fractional shares than whole ones.
With Fractional Shares, Liquidity May Be an Issue
Not every investor wants to keep fractional shares in their portfolio. This might be true for you if these share fractions end up in your portfolio due to reasons beyond your control. Stock splits are a perfect example of such reasons.
Suppose you own 225 shares of stock X, whose per-share price stands at $12. If a 3-for-2 split occurs, you’d have 337.5 shares with a per-share price of $8. To get round things up, you’d need to buy half a share from a broker or sell the half share and keep 337.
Unless stock X is in high demand, you would likely struggle to buy/sell that half a share. That’s because fractional shares don’t trade as quickly and often as whole shares.
This has a lot to do with how both share types trade.
Unlike whole shares, fractional shares don’t trade in the open market. Any brokerage firm that allows its customers to buy/sell fractional shares has to wait to accumulate enough share fractions to make up whole shares.
This wait slows down the filling of orders, subsequently increasing the time it takes to liquidate fractional shares. Add to that the general effect of demand and supply on stocks, and liquidity becomes an even bigger issue when you’re trying to sell/buy fractions of stock with low demand.
Stock Availability May Be Limited With Fractional Shares
Since fractional shares don’t trade on the open market, their availability hinges on brokers’ policies. Not all brokerage firms allow fractional share investing. Even when available, this form of investment may not be offered to all customers.
Brokerages may also put limitations on which types of securities you can trade via fractional share investing.
It could be that you only trade share fractions for stocks or Exchange-Traded Funds (EFTs), or both security types. And even when fractional shares are offered for both types of securities, there may be limitations on the eligible types of EFTs and stocks.
Fractional Shares May Come With Trading Limitations
Generally speaking, there are several ways to acquire and sell securities. These are known as order types. Order types come in many forms, with the most popular being market orders and limit orders.
Choosing the right order type for your investment strategy can make trading more effective and even save you money. For instance, a market order may be an ideal option for long-term investments because:
- It’s less costly.
- The decision to buy/sell is based on factors that’ll take months or even years to take effect, meaning the current market price is insignificant.
On the other hand, you may be better served by a limit order if you’re looking to capitalize on short-term market trends because the current market price is very significant.
Ideally, you want to have all the order types available, so you can experiment with different investment strategies to save time, minimize risk, and save money. However, this isn’t always the case when trading fractional shares.
With some brokerage firms, you may be limited to a few order types when selling or buying fractional shares. Most commonly, only market orders will be allowed. On top of these restrictions, fractional share investors may be subjected to other trade limitations such as:
- Being required to maintain specific dollar amounts in their orders.
- Limited/lack of access to after-hours trading.
- Having fewer trading platforms for placing orders. For instance, some brokerage firms will only allow fractional share investors to do that via the firm’s app.
Fractional Shares May Not Give You Voting Rights
Again, this depends on your broker. Some may not allow holders of fractional shares to have a say in company matters. Stash, for instance, won’t give you voting rights unless you own at least a whole share of the company in question.
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